|Central American University - UCA
Number 425 | Febrero 2017
Fiscal Crisis: Between dangers and opportunities
In an interview with FMLN congresswoman Lorena Peña,
chair of the Legislative Assembly’s Financial Commission,
we reviewed all aspects of the government’s financial situation.
She acknowledged the crisis and that it represents a danger, as all do,
but believes it also offers a chance to make profound changes
in a system that has always favored those who have more
at the expense of those who have less.
Farabundo Martí National Liberation Front (FMLN) leader Lorena Peña currently chairs the Salvadoran Legislative Assembly’s Financial Commission after having served as Legislative Assembly president until November 2016. Peña detailed for envío the nature of El Salvador’s public finances crisis, its origin and the complexity of finding adequate solutions.
ARENA left the house cleaned out
EF: What’s the current situation of the government’s finances? Is there a crisis?
LP: Yes, there’s a crisis, but it’s nothing new. A week before Mauricio Funes took office in June 2009, Carlos Cáceres, soon to be the new finance minister, came looking for me. He explained that we were going to receive a bankrupt government and US$2.2 billion issue needed to be fast-tracked to cover May’s short-term debt (less than a year) payments, replace the money from a loan that had been stolen rather than invested in what it was provided for and pay the government’s obligations.
I remember that we ran all over that night and the loan was approved. The National Republican Alliance (ARENA) party told us they had left “the house clean.” But it was more like they had left it “cleaned out” because they hadn’t informed us of a short-term debt they kept hidden. That debt was about US$400 million and was hidden because it wasn’t in Treasury bills, but was the result of a legal reform to subsidize big businesses with certificates and not cash. So what was happening? When those businesses paid their taxes they did so with those papers rather than with money. You’d estimate that a certain amount of currency was going to come in but it would only be a quarter of that or less because they’d give you the rest in those papers and by the end of the year you’d be out that money. They also left a multi-million dollar long-term debt that won’t be paid off until 2036 or 2037. With all this, a big shortfall still remains even with the injection of US$2.2 billion days before taking office.
What we can’t control
In 2009 we received a government with a 6-point fiscal deficit. The government’s fiscal deficit today is 1.5 points, around 44% of the gross domestic product (GDP), and the pension debt is 2 points. Those two debts together add up to 3.5 points and total 63% of the GDP. Even though that level isn’t equal to Spain or Greece’s debt, it’s worrying.
The 1.5% that corresponds to the fiscal deficit is easier to solve because the government can control its current account spending to some degree. But who controls people getting older and having a right to their pension?
The problem is revenue, not expenditures
Even though our tax structure has been corrected, it’s still very regressive. The highest sector pays much, much fewer taxes than the lower sectors. Our country is maintained largely by the value-added taxes paid by the poor majorities on what they consume and by the remittance taxes paid on the money sent home by family members abroad.
Put another way, our problem is revenue, not expenditures. I emphasize this because the Right cynically recommends that we spend less: stop buying medicines for the hospitals and lay off people. They compare it with a family situation and say that if you earn less, you simply have to spend less.
But that’s not valid because a national economy doesn’t work the same way as a household. Capitalist models have shown that crises grow every time public spending is reduced. There’s a multiplier effect for every dollar not spent. If 5,000 public employees are laid off to reduce costs and each of those employees makes $1,000 a month, that’s $5 million less per month or $60 million less in a year. That’s money that no longer goes into the private sector economy because they no longer buy shoes, tortillas, clothes and the like.
To compensate an annual loss of $60 million, the private sector then lays off workers because they can’t be producing such a large inventory of products if fewer people are buying them. With that, unemployment goes up and consumption goes down even further. Value-added and income taxes the government could otherwise collect drop, worsening the crisis still more.
The current crisis started with the pensions
EF: How did the current fiscal crisis start?
LP: During ARENA’s long period in office, it established a series of measures that in the following decades brought about deep indebtedness, a large fiscal deficit. Finances have been in permanent crisis ever since.
First they sold off the most profitable public companies that provided the government with income. Privatization of the pension system with the Pensions Savings System (SAP) Law was passed in 1996; the National Telecommunication Administration (ANTEL), which annually yielded around a billion colons, was privatized the next year and electricity distribution the year after that.
The SAP law shifted almost all active contributors to the new private pension system, which only pays out to retirees what they have accrued in their individual account over their working life as contributors. The only continuing contributors to the government system were those over 36 who chose to stay in it as well as men over 55 and women over 50, who were forced to stay in it, a significantly smaller pool of people who would also retire sooner than the younger workers taken over by the private system. This left the government with the obligation to continue paying the pension of the existing retirees at the time the law was passed plus these two categories, even though it lost most of the fund that would feed those pensions. If that weren’t impossible enough, it also had to pay the pensions of those in the private system once their individual accounts ran out.
That same law established that the government would take on a debt through investment certificates that would represent what was called the “savings” that the contributors had in the public system up until the time they were transferred to the private system. The government would issue a certificate to each contributor who decided to move to the private system or to those under the age of 36 who had no choice in the matter. During that period, the contribution that formed these “savings” was 3% of their salary. However, to issue those certificates, the debt was calculated as if they were contributing 14%. If one had $3,000 dollars in savings, the government would hand over a paper for $16,000. From the start, then the system established it would be paid with a debt.
Only three years after starting the new pension system, its funds were depleted. President Francisco Flores started issuing more and more bonds and the FMLN gave its vote of approval because if it didn’t there would be no way to pay people’s pensions. Finally, we said we wouldn’t allow any more bonds until the system was reformed to put an end to the problem.
Rather than fixing it, ARENA created the Pension Obligations Trust in 2006, still in operation today, as a way to request loans without going through the Legislative Assembly. However, there’s one detail: the government has to pay for the loans that trust gets. And who are those lenders to the trust? The Pension Funds Administrators (AFP), which manage a portfolio of between US$7 and US$18 million. This isn’t a sustainable mechanism and is the main source of our fiscal gap we have.
The bottom line is that the government currently pays pensions to 60,000 people who were left in the public system at the time of the privatization plus 80,000 who, although they are covered by the private system, have already received everything they had in their individual account and are now maintained by the government. The public pension debt alone is now around US$6 billion and growing. Unless this pension system is reformed, the government could even disappear and the debt would keep growing.
Dollarization of the currency created even more financial problems
Added to all this is the country’s dollarization in 2001, which meant collecting all the currency in colóns and exchanging it for US dollars. Since the government didn’t have all the dollars needed to change the bills, it was forced to take on yet another debt, which some estimated at $800 million. As this debt is being paid, it is now down to $150 million.
In addition, the dollarization generated a need for permanent indebtedness because we can’t issue dollars. There are only three ways to get them. One is by selling exporting more than what we import, but this isn’t simple. Even though our trade balance has improved, our imports are always nore than our exports and that deficit can only be covered with a public or private debt. Another way is by receiving remittances, but it encourages a policy of expelling people from the country so the money they send home compensates for the need of dollars here. The other way is through loans.
We also have to repay what they stole
We can’t fail to mention the unnecessary indebtedness to pay for money stolen by previous governments. It’s normal to go into debt to make investments or do public works; that’s not bad policy because nobody puts up infrastructure out of the operating budget. Nobody buys a house with cash; there’s always some sort of credit involved. What’s not normal is that loans would be taken out here, then the money would be pilfered. For example, money was borrowed two or three times for the same thing: twice to build the Diego de Holguín highway, and the same for the Maternity Hospital. The first time they stole the money so always had to borrow again to actually build the infrastructure or the hospital network.
And we’re paying for the money they stole. We just took out a second loan to build the Water Treatment Plant in Las Pavas because the first one was stolen during President Francisco Flores’ term.
A high tax evasion rate In addition to all this, tax evasion here has been very high. One US ambassador calculated the amount at US$1 billion. While we’ve taken measures against evasion, it’s not enough. Along with the evasion there are also the tax expenditures. That’s the money we don’t receive due to the fiscal incentives granted to big businesses that go against grain of the current laws. It’s considered a public expenditure because in practice it’s a subsidy for these businesses. It legally exonerates them from paying income or customs or value-added taxes. We have studies in the Legislative Assembly that calculate these tax expenditures at US$1 billion and show that they haven’t translated into any more jobs or more growth over the last 15 years.
There’s a false belief that if we don’t give them all the incentives they want, they won’t invest here. But any time we make exceptions like these, we need to verify their effectiveness and guarantee that they’re worth it because they really do produce improvements in the GDP or generate new jobs.
The origin of all this
To recap, the fiscal crisis has its origin in the neoliberal measures launched in El Salvador since 1989: the privatization of the banks, pensions and ANTEL; the dollarization; the incentives without results; tax evasion; and suspension of the equity tax and of tariffs. All these measures were consistent with the vision of an emaciated government with its hands tied, and a completely privatized and deregulated economy, all to benefit the business sector exclusively.
The greatest risk
EF: What are the greatest risks in this crisis?
LP: The greatest risk of all is that the Pension Obligations Trust comes to an end in May of this year. We have to guarantee that we don’t default. Right now all the short term loans are local ones, so we owe the national banks. Theoretically we could ask for more loans because the law allows it. But the reality is that they don’t want to lend us any more.
The government can pay the pensions with the Trust loans, but it needs to comply with the due dates and the 3% interest rate. Each year US$150 million is due, payable in three installments. If we don’t comply, they won’t lend any more to cover the pensions. Any unmet due date falls into default.
First of all, it would mean a red alert for El Salvador. Either lenders would be prohibited from lending to us from within or outside the country, or they would charge an 8%, 10% or even 12% rate because payback is dubious. They could suspend disbursements of loans already acquired. The international rating of BanColombia, owner of Banco Agrícola, fell because we hadn’t paid them. No bank wants to take that risk.
What would the national and international private banks do if we default? They have credit cards, lend to small and medium businesses, known as PYMEs, and provide loans for cars, houses and investments. If the government defaults they would raise the interest on all loans to solve their own resulting liquidity problem. So not only would the government be affected. The international banks that operate here have to report healthy portfolios in their home country because they receive subsidies from their own central banks.
In addition, El Salvador’s government collects more money some months than others. When it has less it has always solved its payments by issuing and selling “Letes” (treasury bills). But we can’t do that now. “Letes” are auctioned every Tuesday, but there’s hardly any market for them right now. The last time we were only able to place $8 million in treasury bills and that’s nothing for a government.
What we can’t allow
We can’t allow all the social programs that benefit people to collapse, or send people to the streets through massive layoffs. But we also can’t stop paying pensions. We’re basically between a rock and a hard place.
El Salvador is still a capitalist country, but this government distinguishes itself from other governments of capitalist countries because it’s committed to solving the fundamental problems of the poorest and organizing them politically so they are able as a people to push for the construction of a different society. To achieve this, their basic needs must be solved to they can think and create. Our commitment isn’t just economic; it’s also political and cultural.
The main thing we’ve done
EF: What have the FMLN’s governments done to counteract the crisis?
LP: We’ve conducted a prudent spending policy prioritizing the main programs, the remuneration or payment of salaries and payment of the debt. Those are our priorities. We’re convinced that our problem isn’t one of excessive spending, but of structural reforms that need to be reversed, the worse being that of the pensions. The pension debt is a dagger poised over finances.
We’ve already taken measures against tax evasion, but not enough. We’ve also dealt with the tax system: a reform we made in 2011 establishes that anyone who earns under $503 a month won’t have to pay income tax while increasing by 5% income tax for those earning more than $2,079. Besides being a de facto increase for workers with lower wages, it also improved revenue.
A 1% tax was also placed on financial transactions, which not only represents income from the formal sector, but also helps fight evasion by the informal sector, because a certain amount is returned when members of that sector declare their income. As a way of stimulating transparency, the money of those who don’t declare stays with the government.
The obligatory declaration of capital wealth was approved in 2009 for people with annual incomes greater than $75,000 and assets valued at $300,000 or more. The idea was that if you increased your assets, for example suddenly acquiring three houses, all paid for, but said your income hadn’t increased, you had to explain how you did it. It was a way to control tax evasion a little, along with money laundering; to establish the veracity of your income tax return. The Legislative Assembly repealed it two years later, without FMLN votes, thus protecting the illicit enrichment of the big evaders.
Our social programs
We’ve also taken smaller measures that have been effective. That’s why ARENA says we’ve increased tax collection by $1 billion in a period of five years. It’s true. Where was all this money invested? We’ve invested a large part of it in social programs.
Today we have 85 municipalities free of illiteracy and that took money. It was urgent to initiate, maintain and increase the delivery of uniforms and school supplies, give the glass of milk in the schools, build new hospitals, increase the amount of the Economic and Social Development Fund of the Municipal Governments of El Salvador (FODES) from 6% to 8%. It was necessary to double the health units, maintain 700 Family ECOs—which are community health clinics—and create the Online University. We also moved more than 1,200 schools to full time, where twice as much is spent because the children are in school all day, improving educational quality, something we consider very important.
The University of El Salvador’s budget was also increased. And there was an increase in agricultural packages which used to be sold and now are given free. Unfortunately, another large part of those millions had to be used to pay the pension debt, even though it shouldn’t be this way.
It wasn’t easy finishing 2016
It’s true that work was done to achieve greater revenue, but those achievements still don’t compensate for the drama of tax evasion.
A tax on private bank income was also established because they weren’t paying anything. If you can believe it, the banks were on the list of Charity Associations that are exempt from income taxes. We took them off that list so they would have to pay income taxes, but by the time we pushed that reform through, the bankers had already sold their banks to foreign banks and the sales were exempt from income taxes.
Bolivia bought our last Treasury Bills in 2016, conditioned to the fiscal agreement. With that we managed to finish 2016. But it wasn’t easy.
Those measures allowed us to honor the debt payment and promote new social programs in the coming years. But meanwhile, the pension debt increased by 100% during Mauricio Funes’ term, which had nothing to do with him or his economic policies. It simply responded to the logic of progressive indebtedness implicit in the SAP Law.
The SAP law: The dagger in the finances
EF: What solutions are envisioned for the crisis?
LP: We’re now in a financial situation with a well-designed and sustainable medium-term framework and a spending policy
that prioritizes the main programs of infrastructure improvement, agricultural reactivation, scientific research, promotion of PYME networks, grassroots tourism, social programs and the like. The payment of salaries, remunerations and payment on the debt are also prioritized.
On the other hand, we have a series of initiatives that improve income in the short, medium and long term. And finally, we’re strengthening a plan to attract strategic investments that will leave us with new knowledge and skills and not only assembly plants and call centers.
All these will produce visible fruits once we can reform the pension system, which will really solve the fiscal problem. The problem is that the Right will move heaven and earth to prevent passage of such a reform. There’s nothing surprising about this with Mauricio Interiano, chair of the committee led by ARENA, and a former executive with AFP Crecer. The reform we’re proposing is that the government receive the money from the workers to pay workers’ pensions.
We need legislative power
It’s not impossible to approve the SAP Law reform without ARENA’s votes, but a favorable correlation of forces around this issue in the Assembly it isn’t easy either. And it needs to be resolved now because if it drags out until the end of this year, it’ll be too late and the money that comes in won’t cover the $300 million we need for this year. Another measure that would relieve the situation is to reestablish the Equity Tax, which President Alfredo Cristiani suspended in 1990, and the Capital Wealth Declaration proposal should also be revisited. But, as I say, achieving the correlation of forces to get these proposals approved in the Assembly isn’t easy.
Even if we cry tears of blood
If we can’t push the reforms through, even if we cry tears of blood, we’ll be forced to increase the value-added tax by a few points. But I’ve done the math and a family with two children and the equivalent of two minimum wages doesn’t pay income tax because each earns less than $500. If they completely consume both wages in a year, they would currently pay about $550 in value-added tax. If that tax were increased by 2%, they would pay $669, but what they receive in school packages and the glass of milk for their children, subsidies for water, gas and electricity and health care in the new health units or in the ECOs adds up to approximately $1,600. So cutting out the social programs would be more harmful than increasing value-added taxes by 2 points.
Other things also need to be done. One is to seriously attack tax evasion. That’s why there’s talk about the need for a Coercive Collection Law, which would allow the government to force evaders to pay, even if they haven’t yet gone through the judicial system. Evasion could also be decreased if the existing laws were enforced with a firm hand. Revenue could be increased by $15-30 million per month.
New loans aren’t impossible either
And who thinks ARENA wouldn’t approve new loans if it feels too pressured? It actually might approve them. But as I said, all these kinds of things depend on the correlation of forces in the Legislative Assembly. Stranger things have happened. For example, when BanColombia’s international rating dropped due to El Salvador’s failure to pay, its owners began to pressure the Right to come to agreements with us and that really helped.
Solving the pension problem won’t solve everything, but it would solve a lot. Reviewing indicators, the government has reduced its fiscal deficit and improved a primary balance to almost positive, and did it without being able to print money or use the profits from state businesses. And also without being able to use the savings of those who have to help pay their own pensions because their original pensions were lost with the neoliberal measures.
Listening to Congresswoman Lorena Peña talk about the crisis, a repeated reflection kept coming to mind. The people of China and Japan write the word “crisis” by joining two graphic characters: one representing “danger” and the other representing “opportunity,” the less evident side of the coin but present in all personal, social, national or international crises.
El Salvador’s fiscal crisis offers opportunities for profound and much-needed changes in the Salvadoran State’s financial management because it puts in checkmate a system that has favored those who have more at the expense of those who have less.
There are answers. What’s missing is for those who have more to heed what Monsignor Romero warned them many years ago: “You better take off your rings so they don’t cut off your fingers.”
Elaine Freedman is a grassroots educator and the envío correspondent in El Salvador.